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Lobby of the Ontario Securities Commission on Tuesday, May 8, 2007.Philip Cheung

When Zungui Haixi Corp. applied to go public on the TSX Venture Exchange two years ago, some on Bay Street took it as a sign that things were looking up.

The previous year had been the worst in recent memory for new listings on the country's stock exchanges. But Zungui, a maker of shoes for Chinese consumers, was selling a good story at the right time – just as China's economy was showing signs of a swift rebound. Investors bought it, investing nearly $40-million.

Today, they wish they hadn't. Their shares are likely worthless and might never trade again. Zungui's auditors have quit, as have its independent directors and its chief financial officer. And on Tuesday, the Ontario Securities Commission accused the chairman and chief executive officer of violating the public interest in a number of ways, including mishandling an audit and failing to co-operate with a regulatory investigation into the company's finances.

Zungui has become a symbol of what has gone wrong with Chinese businesses listed on Canadian exchanges. The regulator's fresh allegations against the Chinese company come amid a broader policy review by the OSC of procedures for foreign companies that list in Canada, which was launched in July after an investment firm accused Hong Kong-based Sino-Forest Corp. of operating a "multibillion-dollar Ponzi scheme."

Zungui listed in Toronto at a time when investors were hungry for Chinese exposure. The company had hired action-flick star Jet Li for its commercials, adding a bit of sizzle to the story.

Its operations were based entirely in China and it intended to sell its shoes only in China, but it chose to list in Toronto, according to its website, because it believed that Canadian exchanges offer smaller firms access to capital and that investors here were interested in China and high-growth companies. In addition, it noted that the Toronto Stock Exchange was "actively promoting the Canadian exchanges to Chinese companies."

The market value of Chinese companies listed on Toronto's exchanges grew from $3.2-billion in 2006 to $12.8-billion in 2010.

Zungui's prospectus said China's sportswear industry represented a $7.7-billion market that was growing at 30 per cent a year. It said the company's revenue tripled from $50.2-million in 2006 to $152.4-million in 2009.

In August, however, Zungui's auditor, Ernst & Young, suspended its audit work, saying it had problems with bank documents and invoices it examined. Zungui's stock plunged 75 per cent and was suspended from trading the next day.

Investors who read the prospectus might have seen a paragraph, typed in boldface near the beginning, that warned that the company's largest shareholder – Yanda Cai, who would also be its top executive – was not a Canadian. The OSC now says the CEO "prevented independent verification" of the cash balance in Zungui accounts.

Steve Conley, a management consultant and entrepreneur, is one of the investors who read the prospectus thoroughly. Mr. Conley, who has invested in Chinese-based, North American-listed stocks over the last three years, declined to say exactly how much money he invested in Zungui last year but it is in the "six figures" and represented the largest holding in his family's investment portfolio.

A seasoned investor, Mr. Conley not only read the prospectus, he had attended one of the company's annual general meetings and talked to directors of the firm, the CFO, and analysts.

He knew of the risks that make it hard to conduct searches and collect judgments in China, but he didn't think it would ever be an issue. "I had done enough due diligence to satisfy myself that a real building was there. "Lots of people had seen the manufacturing, people had actually been in the plant and counted boxes coming off the assembly line."

Mr. Conley also received comfort in the fact that banks like CIBC had underwritten Zungui's initial public offering and that it was audited by Ernst & Young.

But when the auditing firm identified inconsistencies in the company's bank documents and invoices, a special committee of independent directors was formed to look into the matter. Zungui's CEO and chairman refused to meet with the committee or co-operate in its investigation, so the independent directors and chief financial officer resigned in September, leaving the company with no senior Canadian representation. E&Y also resigned as auditor.

Cash makes up the bulk of Zungui's assets, and it's believed to be predominantly in bank branches in China. But to access those accounts, an individual needs a corporate seal that is controlled by the CEO.

The OSC has tried unsuccessfully to access documents and records of Zungui's in China, and says it would need the co-operation of the CEO or chairman to produce them. The regulator revealed that those two executives have stonewalled Canadian securities regulators' attempts to investigate the company, refusing to answer the OSC's letters or reply to requests for documents.

The regulator alleges Zungui is in breach of Ontario laws because it has no remaining audit committee members and has failed to file year-end financial statements.

The OSC suggested it hasn't given up yet, saying its investigation is "ongoing." But for now, all it can do is seek to ban Zungui, its CEO and its chairman from further participating in Ontario's capital markets.

In the meantime, Mr. Conley's frustrated that these companies were allowed to list in Canada, and said that investors are contemplating going to China to get results.

"You shouldn't list a company on the public markets if there aren't some controls in place that allow you to do something if something like this happens," he said. "What we're probably going to try to do is see if we can find a way to get accountability within the jurisdiction that they're operating in."


Zungui Haixi Corp. makes and sells athletic shoes, clothes and accessories in China. It concentrates on secondary cities rather than big commercial centres such as Beijing and Shanghai, and notes that there are more than 60 cities with a population of more than one million.

It claims to rank No. 8 in terms of Chinese sportswear brands. It distributes its products through a network of more than 2,000 stores, and says it sells more than 11 million pairs of shoes annually.


The company listed on the TSX Venture exchange on Dec. 21, 2009, raising $40-million. Its ticker symbol is ZUN. Zungui is a holding company that conducts its business through a Chinese company called Mengshida, founded in 1992.


Zungui's CEO is Yanda Cai, and the chairman is his brother, Fengyi Cai, who owns more than 56 per cent of the stock. The two brothers founded the company, whose prospectus says "they have played an integral role in the growth of Mengshida from a small family business to its current position."

Tara Perkins